While U.S. stocks have outperformed foreign stocks in recent years, some types of foreign bonds have held up well. Taking a slightly longer view, funds holding bonds from emerging markets have topped all of Morningstar’s bond fund categories for the 10 years through September 2014, with average annualized returns around 7.6%. By contrast, the average return for all taxable bond fund categories was about 4.5%.
Why have emerging markets bonds done so well? For one reason, they have relatively high yields. The stocks in the J.P. Morgan Emerging Markets Bond Index have a current yield over 5%, which can be appealing in today’s low-yield world.
In addition, emerging markets generally have faster economic growth than the U.S. and the developed markets of Western Europe. As their economies expand, emerging nations likely will become more creditworthy, making their bonds more valuable. These trends, which have sparked gains in emerging markets bonds during the last decade, may continue in the future.
Nevertheless, bonds issued in places such as Brazil, Russia, India
and China can be risky, so prices may fluctuate. If you are interested in a small portfolio allocation to this asset class, consult with your investment advisor. You might consider a diversified emerging markets bond fund to spread the risks. Funds in this category may be less volatile if they primarily hold government rather than company bonds.